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Saturday, June 7, 2008

Why I Believe In Free Markets

About ten years ago I went with a group of friends to see the Dave Matthews Band in concert. One of my friends in the group happened to be working at a ticket broker's at the time, and thus we got our tickets cheap from the extras that the broker didn't sell. We got this deal on the condition that my friend would sell all the rest of the tickets that the business hadn't sold. My friend had become an expert on selling tickets outside a concert. The first thing he did was he walked through the crowd to get a feel if this was a buyer's or seller's market. He did this by seeing whether or not he noticed more people asking for tickets or asking to sell tickets. He immediately noticed that everywhere he turned someone was asking for tickets.

He placed himself in an appropriate place in the crowd and announced that he had a ticket to sell. Immediately, he got one response at $20 dollars. Then, another person approached at $30, and then $40. Now, it was a full out bidding war. The price reached nearly one hundred dollars as more and more buyers attempted to out bid each other when the police arrived and reminded all that scalping was in fact illegal.

While the story of scalping tickets may in fact be a crude way of showing why free markets are the best, this story in fact shows much of what makes free markets best. Since my friend had a valued commodity and a commodity that was in short supply, he had all the power in the market. Furthermore, as more buyers approached this single seller the price continued to rise. It was supply and demand not in theory but in practice.

That is the lesson of free markets. They aren't perfect, but always they are pure. Unlike any artificial stimulus, limits, or regulations they guide the environment purely with no regard for sympathy, status, or power. The only thing the market cares about is the natural equilibrium. It is likely that had the cops not jumped in one of those poor concert goers would have way over spent for Dave Matthews, but isn't that the point. If you are competing with all sorts of other players for a good in demand but in short supply you will overpay. Therein lies the lesson.

America's sudden change in car-buying habits makes suitable mockery of that absurd debate Congress put on last December on fuel efficiency standards. At stake was precisely what miles-per-gallon average would every car company's fleet have to meet by precisely what date. It was one out-of-a-hat number (35 mpg) compounded by another (by 2020). It involved, as always, dozens of regulations, loopholes and throws at a dartboard. And we already knew from past history what the fleet average number does.

When oil is cheap and everybody wants a gas guzzler, fuel efficiency standards force manufacturers to make cars that nobody wants to buy. When gas prices go through the roof, this agent of inefficiency becomes an utter redundancy.

At $4 a gallon, the fleet composition is changing spontaneously and overnight, not over the 13 years mandated by Congress. (Even Stalin had the modesty to restrict himself to five-year plans.) Just Tuesday, GM announced that it would shutter four SUV and truck plants, add a third shift to its compact and midsize sedan plants in Ohio and Michigan, and green light for 2010 the Chevy Volt, an electric hybrid.

Some things, like renal physiology, are difficult. Some things, like Arab-Israeli peace, are impossible. And some things are preternaturally simple. You want more fuel-efficient cars? Don't regulate. Don't mandate. Don't scold. Don't appeal to the better angels of our nature. Do one thing: Hike the cost of gas until you find the price point.

Look at what has happened to the mortgage market in the aftermath of the crisis. The market has nearly eliminated on its own all the troubling loans: stated, no money down, interest only, option arms. All of these loans are nearly eliminated by the fell swoop of the market. Politicians have been debating all sorts of new rules and regulations. The market needed no such deliberation. It merely identified all that was wrong and cut it all out like it had an axe.

So, what happens when politicians try and substitute their own judgement for that of the market's? For instance, we had the well meaning but flawed legislation that mandated more ethanol use. As such, we what now have is exploding food prices because fields that should have been used for growing food are being used to grow corn for ethanol. Look at the well meaning idea of minimum wage. Lot's of people are concerned about all the illegal immigrants flooding across the border. Why do businesses hire them? It's because illegals are perfectly comfortable working for less than minimum wage. Maybe if there was no artificial floor, businesses wouldn't need to break the law. Rather than letting the market set mimum wages bureaucrats do and thus business finds illegal workers to work outside their floors.

So, the lesson is that while the action maybe well meaning it is in fact one full of hubris when a politician replaces the judgement of the market with their own. Whereas the market set $4 a gallon as the price that naturally changed behavior, when politicians tried to do it themselves they merely caused an explosion in other prices. Such are the lessons that everyone should keep in mind as we continue to debate mandates, regulations, and new laws in mortgages, oil, and other industries. Be wary of the politicians that promises new regulations as the answer. I am not against regulations out of hand, however I am against anyone that makes regulations, rather than the free marketer, the arbitor of what is best.